The market is seeing new highs, but not all stocks are going along for the ride. New records for the S&P 500 and the Dow Jones Industrial Average confirm that performance has been good for large cap, blue chip stocks. However, as we move down the market capitalization spectrum, the story changes.
Instead of establishing new highs, the Russell 2000 Index of small cap stocks was sitting below its 200-day moving average this week. While new highs in the large cap stock indexes have been the subject of financial headlines, small cap stocks have been taking a beating. The Russell 2000 was also making new highs earlier this year, and although it was less than two months ago, it may seem much longer.
Magnitude has been more important than time when looking at the recent declines in small cap stocks, but relative performance landed the biggest hit. The Russell 2000 Index dropped more than 8% in about a six-week period. Declines of this magnitude are never fun, but stock investors have been conditioned to accept them as part of the equity investment landscape.
Under most conditions, an 8% decline in six weeks is not that big of a deal. However, this particular time is not typical once the performance of the broader market is taken into consideration. The S&P 500 actually posted a gain during that same period. It was not a huge gain, but still a gain and not a loss. Not only did the S&P 500 gain ground, it established new lifetime closing highs. The 8% pullback in the Russell 2000 Index was not just a market related decline, it was an 8% to 9% relative underperformance. Combined with the fact it occurred in just six weeks makes it not something to just shrug off; it is a big deal.
For more than 15 months, the Russell 2000 Index was outperforming the S&P 500. From December 2012 until March of this year, small cap stocks slowly and steadily built up a hefty performance premium over their larger brethren. The work done by the small caps over those 60 weeks was all undone in just six weeks. The destruction took just one-tenth the time of the construction. This is what makes the 8% decline of the Russell 2000 so painful.
On Monday, small cap stocks joined the broader market in a nice rally. Since then, the large cap benchmarks have held most of their gains. Meanwhile, small cap stocks have given back nearly half of their recent gains, and the Russell 2000 was trading back below its 200-day moving average.
It was somewhat of a volatile week for Energy, but it managed to keep its #1 ranking. Real Estate moved up to second place after a four-week stint in third. With Energy and Real Estate holding the top two spots, land with an oil well or two on it is probably a great thing to own right now. Consumer Staples has been one peg below Real Estate for many weeks, and today it continues that trend by also moving up one spot. Telecom and Materials each climbed a level, too. Industrials rounds out the five sectors that moved up one notch in lockstep to now occupy the second through sixth places. One factor behind the rise of these five sectors was the dramatic fall of Utilities from second to seventh. The Utilities sector has been a top-performer for more than two months. Its setback is cause for concern, especially in light of the positive performance from the broader market. However, it’s still registering positive momentum and is sitting above its 50-day moving average, so there is no need for alarm. The lower tier consists of the same four categories for six weeks running. Technology, Financials, and Health Care are in a near three-way tie for second-to-last place, while Consumer Discretionary has the bottom to itself. Homebuilders are part of the Consumer Discretionary sector, and they have been performing poorly. This may appear to be in conflict with the strength of Real Estate, but what it really implies is that the market is favoring owners versus builders.
Mid Cap Value surrendered the top spot to Large Cap Value for three weeks, but today it reclaimed that position. Large Cap Value didn’t fall far. It had a positive week and landed on its feet in second place. The remaining nine categories are all in the same exact relative order as a week ago. Mega Cap, Large Cap Blend, and Mid Cap Blend round out the top five. Small Cap Value was able to shed its negative momentum, but with a score of zero, it can’t claim having positive momentum either. Small Cap Blend, Small Cap Growth, and Micro Cap remain in negative trends at the bottom of the heap.
Latin America finally broke out of its long-term downtrend a little more than a week ago. It continued its upward move this past week and put further distance between itself and second place U.K. Emerging Markets moved from sixth to third on strength in Latin America and a rebound in Russian stocks. Canada, Pacific ex-Japan, and Europe each slipped a spot as a result of the recent gains for Emerging Markets. EAFE, World Equity, and the U.S. kept their relative positions and showed improvement. China and Japan continue to be the only global regions in the red, but they are on a path to change that soon. Today, Japan moves back into last place after besting China for a week.
“Small Caps can underperform without impacting the broader market and don’t forget that Small Caps will usually bloody both knees on the playground once a year”
Blaine Rollins, former manager of Janus Fund, May 12, 2014
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